California Reporting Requirements for Canadian RRSP’s

Sometimes the tax consequences at a Federal level are different than that at the State level.

Such is the case in California when dealing with a Canadian Registered Retirement Savings Plan (RRSP).

As explained in Revenue Procedure 89-45, a Canadian RRSP is not an Individual Retirement Account (IRA) because “these plans do not meet the requirements for qualification as individual retirement accounts under section 408(a) of the Internal Revenue Code. As a result, the earnings of such a plan are includable currently in the gross income of the beneficiary of the plan for United States income tax purposes.” Rev. Proc. 89-45; superseded by Rev. Proc. 2002-23. 2 Rev. & Tax. Code, § 17501. Because California also conforms to federal law regarding the treatment of IRA’s (Rev. & Tax. Code Sec 17501), an RRSP does not qualify as an IRA for California income tax purposes.

Revenue Procedure 89-45 then explains that for federal income tax purposes, a taxpayer may elect to defer the taxation of earnings on contributions made while the beneficiary is a resident of Canada, until the earnings are distributed from the RRSP. This special treatment is provided in accordance with a treaty between the United States and Canada, and does not apply to California.

The State Board of Equalization has previously held that tax treaties between the United States and other countries which expressly limit their application to federal income taxes do not prevent California from taxing persons otherwise covered by such treaties.” Appeal of M. T. de Mey van Streefkerk, 85-SBE-135, Nov. 6, 1985. The United States Supreme Court noted that “the tax treaties into which the United States has entered do not generally cover the taxing activities of subnational governmental units such as States … and if the treaty does apply to the States it will be specified in the treaty itself. Container Corp. v. Franchise Tax Board (1983) 463 U.S. 159, 196. Accordingly, the federal election to defer taxation on earnings of the RRSP is inapplicable for California income tax purposes.

Basically, the Franchise Tax Board considers a RRSP to be similar to a savings account. The Franchise Tax Board will treat a taxpayer’s original contributions to the RRSP, made while a Canadian resident, as a capital investment in the RRSP. A California resident must include any earnings from their RRSP in their taxable income and pay taxes on this income in the year earned. After a taxpayer pays tax on these earnings, the earnings will also be treated as capital invested in the RRSP. Therefore, when a taxpayer receives a distribution from their RRSP, the amount consisting of the contributions and the previously taxed earnings is considered a nontaxable return of capital.

In summary, under both federal and California law an RRSP does not qualify as an IRA and does not receive IRA treatment. The federal treaty that allows taxpayers to elect to defer taxation on their RRSP earnings until the time of distribution does not apply for California income tax purposes. California residents must include their RRSP earnings in their taxable income in the year earned.

California taxpayers who have an interest in a Canadian RRSP would benefit from the experienced tax attorneys of the Law Office Of Jeffrey B. Kahn, P.C. representing you to avoid the pitfalls associated with failure to comply with the reporting requirements associated with having an interest in an RRSP.

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